Liquidity and a No-Bid Market

Apparently, the going rate for a 404 point rally on the Dow Industrials is $1 trillion. Any takers? Going once… 

After stocks lost $1 trillion during that surreal 2 minute stretch last Wednesday, it’s nice to get that market-cap back. But there is still work to do. 

Yesterday’s rally took the S&P 500 within range to challenge resistance at 1,165. It will be important for the S&P 500 to move above this level today.

The massive bailout was intended to send a message. And taking out an important resistance point like 1,165 is a great way for investors, both bulls and bears, to say the message is getting through, loud and clear. 

The EU’s $1 trillion response to debt problems in Greece and potential problems in other countries was at least 3 times bigger than what the market was expecting. 

And truth be told, it wasn’t just the EU taking action. The Fed and the Bank of Japan reopened their dollar swap facility to provide dollar liquidity. 

Both the size of the bailout funds and the actions of the Fed and Bank of Japan would not have been necessary were it not for the events of Thursday, May 6. That was the day the stock market briefly went no-bid… 

NYSE officials, stock market pundits and even a Congressman or two have gone to great lengths to explain how the Dow Industrials dropped 500 points in a matter of seconds, and how some stocks lost the majority of their value in an instant. (By now, you’ve probably heard how Accenture (NYSE:ACN) dropped to 1 penny a share). 

There was the “fat finger theory”, which suggested that a trader at Citigroup (NYSE:C) hit “billion” instead of “million” on a sell order. But Citigroup had no erroneous trades that day. 

The “hedge fund liquidation theory” was quickly put to rest. 

Then there’s the “high-speed trading theory” that some members of Congress have adopted. High-speed trading is computer-based trading where computers enter buy or sell orders based on things like if a stock or index drops by a certain percentage. 

It’s basically momentum trading designed to scalp pennies. High speed trading accounts for 50%-75% of the trading volume each day. The theory goes that the steep declines already occurring on Thursday set off a huge wave of programmed selling that sent prices to ridiculous lows. 

What’s scary about these program trades is not that they lack a human element. The truly scary thing is that there were no buyers on Thursday. The stock market had essentially gone no-bid. 

A stock is only worth what someone will pay to own it. And last Thursday, nobody wanted to buy. The Greek situation had become a crisis, gold was rallying, oil was selling off, yes, the correction for the overbought market was at hand. 

Most investors know that it’s not wise to try and “catch the falling knife.” Better to wait for a decline to stabilize before trying to catch the rebound. 

Most investors are also aware of the term “capitulation.” Capitulation refers to the point during a bear market at which investors simply give up and sell. Capitulation usually marks a stock market bottom because there is no one left to sell. 

Last Thursday, we saw the opposite. For a few minutes, there was no one left to buy. 

Liquidity was a major factor in the stock meltdown in 2008 and in the failure of Lehman Brothers and Bear Stearns. But the funny thing about liquidity is that you don’t notice it’s not there until things start failing, like banks, Greece or the stock market. 

Liquidity is confidence (and I don’t mean liquid courage). It both measures confidence and provides confidence. A no-bid stock market, on the other hand, does not inspire confidence. In fact, Thursday’s no-bid market drained every bit of confidence that had built up since the March 2009 lows. 

And so, the EU, and the Fed, and Japan, simply had to come up with an absolutely absurd amount of liquidity to restore some of that lost confidence. $1 trillion to support Greece is absurd. And for yesterday, at least, investors were confident that the stock market wasn’t going to sell-off again. 

That’s why we need to take out an important resistance point or two (like S&P 500 1,165 and 1,188). We need to see some confidence. 

In fact, I want to see three solid up days in a row. This is a bullish candlestick pattern called “three white soldiers.” The three white soldiers herald the start of a bull run for a stock or index. 

I suspect that last week’s market crash (even though it was brief, when a market goes no-bid, it’s a crash) and the liquidity response from Europe is going to cut the teeth out of the banking reform bill that’s in Congress. 

The last thing the stock market and the economy needs is bill that will impair banks’ ability to earn. 

Because if we ban proprietary trading at banks, for instance, bank profits fall, so do their stock prices and so does the S&P 500. Other measures to tie compensation to performance shouldn’t be affected.

I just recommended a stock to Energy World Profits that’s moving from a $0.03 loss in 2009 to a $0.14 a share profit in 2010 and $0.38 a share in 2011 – all because of its Bakken operations. 

Strong hands are buying this stock. I look for a strong move above $4 in the near future. 

You can learn more about Energy World Profits HERE. You won’t be disappointed.